Why Microfinancing Works

Banking the unbankable can prove to be a smart investment for cities and states.

A Special Report by Adam Bluestein and Amy Barrett

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Hester and Jason Rodriguez learned quickly that banks weren't going to be much help to them in their dream of opening a restaurant in Corpus Christi, Texas. The couple had what they thought was a solid plan, plus about $20,000 in savings and a stash of used restaurant equipment. But even though the couple owned their home, bankers felt they lacked sufficient capital and denied their loan applications. Fortunately, the city's Small Business Development Center pointed them toward Accion Texas-Louisiana, a nonprofit microlender that was willing to make a low-interest loan of $25,000. (The interest was made even lower by a Corpus Christi program that buys down debt for new and existing small businesses that can create jobs.) It was just enough to get Hester's Café up and running.

Four years later, Hester's is a beloved institution in a neighborhood with few dining options. After paying off their first loan, the Rodriguezes went to Accion for another, this time to finance an expansion. Hester's has 22 employees, who now have the option of buying into an employer-sponsored health insurance plan, a rarity in the restaurant business. Says Hester: "Our business is far bigger than anything we dreamed of."

Over the past few years, many mainstream banks have beefed up loan requirements or significantly cut back on small-business lending. Nonprofit microfinance lenders have come to play an ever more important role in bridging the funding gap.

Accion's loan originations in 2009 -- for restaurants, nail salons, landscaping and pool services -- hit a record $16 million. Average loan size is about $15,000, with a historical repayment rate of 95 percent, despite lending to customers with poor credit and in industries, like food service, with high rates of failure, says Gary Lindner, Accion's chief operating officer. Eighty-six percent of clients are minorities, and 45 percent are women; median household income is just under $30,000. From 1994 to 2009, Accion loans -- more than half were made to the founders of start-ups -- have created or sustained nearly 6,000 jobs.

How does Accion manage to bank the unbankable? "We have built a very comprehensive, automated risk-assessment system, modeling the characteristics of a good client, which is not necessarily just good credit," Lindner says. "But the bigger impact comes from our internal culture. Only two out of our 30 loan officers have a banking background; they're all from the communities we serve, and they're good at discovering people who are unscrupulous."

As a community development financial institution, or CDFI, Accion lends about $1.5 million a month in its own funds, and provides underwriting services for 15 other small-business lenders nationwide. Lindner says the model can work anywhere, and stats from microfinance institutions in other parts of the country bear that out. Opportunity Fund, in San Jose, serves a similar demographic and enjoys a similar repayment rate; a new independent study showed that every dollar invested by the fund into small businesses had a financial return of 2 to 1 in new wages, spending, and tax revenue throughout the region.

Cities and states should embrace these kinds of programs. California's CalCap program, for example, provides a reserve for lenders that take on riskier loans. The federal government already helps -- especially through CDFI funds from the Treasury Department and certain SBA loan programs -- but it could do more. Most federal money goes to banks and other heavily regulated institutions, rather than nonprofits. That's a mistake, says Eric Weaver, founder and CEO of Opportunity Fund. "There's an understandable concern with taking a risk with public dollars," Weaver says. "But if you can satisfy yourself that a financial institution is doing it with a mission in mind, it's a good kind of risk. And it has a real upside."

Just ask Hester and Jason Rodriguez. Or someone who works for them.

Bottom Line Businesses that seem to be unbankable often are anything but -- if you know what to look for.

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It's difficult, if not impossible, to say how many new companies Inc.'s 16-point plan would help create. We went over our proposals and performed some back-of-the-envelope calculations and estimate that implementing these ideas would spur the formation at least 300,000 additional start-ups over the next decade or so. That number, we admit, is speculative. But blue-sky thinking is fine with us. The point is that the old models are no longer working. We need bold thinking about how a new wave of entrepreneurship can transform the American economy, spark innovation, and provide new jobs, new vibrancy, and new opportunities.

That's where you come in. What do you think of our plan? Is anything missing? What do you think needs to happen to make this country more start-up friendly? We want to hear from you. Post a comment at www.inc.com/startup-economy-2010.